The National Research Council has recommended that a government small business …

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The United States runs a grant program that is meant to provide support to small businesses with technologically advanced and innovative ideas, intended to stimulate scientific industry. In 2002, a ruling was made that prevented small businesses that already received significant funding from investment firms from also obtaining these government funds. Recently the National Research Council formed a committee to revisit this ruling and determine whether excluding well-funded small businesses from these grants winds up excluding some of the best ideas that small businesses have to offer.

The Small Business Innovation Research program, created in 1982, is intended to provide federal funding to high-tech start-up companies. The awards are competitive and meant to stimulate technological advancements that can ultimately be used by government agencies. SBIR funding has played a critical role in supporting some projects in their early stages. Startups can also obtain funding from business angels, state governments, universities, and other sources, but these groups can become more conservative as the economy dips. The SBIR program provides a consistent source of funds that doesn't fluctuate along with the economy.

In 2002, the Small Business Association ruled that SBIR funding could no longer be awarded to companies who were not held 51 percent or more by individuals—that is, if venture capital firms or other private equity groups had a controlling interest in a company. This ruling effectively meant that small companies could opt for SBIR funding or be deeply involved with private investment firms, but not both.

Proponents of the ruling say that this makes the distribution of SBIR funds more fair: companies that are already fairly well-funded don't get more money, while firms that couldn't win venture capital may still get money to develop. Helping businesses that are growing on their own would be contrary to the purpose of small business funding. However, the National Institutes of Health and biotechnology companies have argued that the rule is denying money to the projects that are the most interesting.

The NIH turns out to be correct on at least one level—the companies that are most affected by the rules are the ones that have the most promising technologies. If an idea is both practical and innovative, it makes sense that firms would want to invest in the project. In its studies, the committee found that companies that receive both venture funds and SBIR funds are slightly less likely to eventually market their developments for commercial use but, when they do, their products sell very well.

Companies developing technologies that don't draw the interest of venture capital firms but do receive SBIR funding commercialize more often, but their developments don't sell nearly as well. In effect, this current rules seem to be punishing the most promising and profitable projects for being so viable.

One of the additional goals of the SBIR program is to encourage long term commercialization of federal research. The goal is apparently not being fully met because of the limited commercialization potential of the projects that receive SBIR funds. The committee also found that the government isn't just being mean to the smart kids in class; they're hurting themselves too. By not investing in the most promising projects, the government is denying itself the biggest return on its investments and access to new, cost-effective technologies that it can use.

The committee ultimately recommended a change to the policy. They suggested either restoring the terms of the funding to its former state by removing the 2002 restriction, or adding a provision for the venture-funded companies that are being adversely affected by the current rule.

The one notable gap in the logic of the report is the assumption that all companies interested in SBIR funding are at the peak of their potential. Removing the restriction on controlling interest entirely could be bad news for small but promising companies that can't yet get attention from venture capital firms, ultimately preventing them from reaching the point where they could receive private capital. The SBA would have to exercise care to ensure these companies continue to receive funding if it decides to heed the committee's recommendation and rethink its ruling on firm-owned companies.

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Casey Johnston
Casey Johnston is the former Culture Editor at Ars Technica, and now does the occasional freelance story. She graduated from Columbia University with a degree in Applied Physics. Twitter@caseyjohnston